How Crowdfunding Works

The History of Crowdfunding

In 2012, Pebble Time raised more than $10 million on Kickstarter to fund its smart watch. In 2015, it doubled that to more than $20 million for the second version of the watch, the biggest amount ever raised on Kickstarter.

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You may think crowdfunding is a newfangled thing. The name is, but the practice has been around for hundreds of years. In the 1700s, author Jonathan Swift created the Irish Loan Fund, which lent small amounts of money to rural, low-income families for short periods. A century later, more than 300 similar programs were sprinkled throughout Ireland; at one point, 20 percent of all Irish households were receiving these loans [source: Clark].

Fast-forward to Bangladesh, 1976. Dr. Mohammad Yunus and his graduate students joined forces on a research project: lend small amounts of money to poor people so they could create businesses and become self-employed. The group first lent $27 to 42 women. Within five years, the program had more than 30,000 members. In 1983, it formally became Grameen Bank. Yunus and Grameen Bank won the Nobel Peace Prize in 2006 for their work in economic and social development [source: Clark].

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The first Internet "crowdfunding" success happened in 1997 when a British rock band funded its reunion tour by soliciting online donations from fans [source: Fundable]. In 2003, musician and composer Brian Camelio created ArtistShare, the first official, dedicated crowdfunding platform. ArtistShare connected artists and fans so the two groups could join forces in the creative process while also funding new artistic works. Projects funded through ArtistShare have received nine Grammy awards and 18 nominations [source: ArtistShare].

Next came Kiva.org, the first microlending website. People lent small amounts of money to entrepreneurs in developing countries. The first peer-to-peer lending site in a developed country (the U.S.) debuted in 2006 — Prosper.com. Applicants submit a request for funds, along with their story, a photo and their credit risk. Interest rates for loans are generally less than those offered by financial institutions [source: Clark].

Today's well-known crowdfunding site, Kickstarter, was launched in 2009 to help people fund a project or product, such as a CD, documentary, smart watch or, yes, a batch of potato salad. Like ArtistShare, the funds raised aren't loans to be repaid. Rather, donors receive small rewards based on the amount they donate [source: Clark].

With crowdfunding increasingly important to America's small businesses, President Barack Obama in 2012 signed into law the Jumpstart Our Business Startups (JOBS) Act. Aka the "crowdfunding bill," it legalized equity crowdfunding, among other provisions [source: Fundable]. Crowdfunding was officially part of the American economic scene.

There have been enormous successes. In mid-2015, the most profitable Kickstarter campaign, Pebble Time, raised more than $20 million to produce a smart watch [source: Zipkin]. Pebble Time could probably have raised their cash from a more traditional source, but that wouldn't have gotten the marketing buzz generated by the super-successful campaign. Plus, it gave them a pipeline to their most loyal customers — the folks who helped fund their earlier Kickstarter campaign for the first version of the watch [source: Hern].

But before you get started on your own campaign, know this: Most crowdfunding projects fail.